Board of Governors of the Federal Reserve System
International Finance Discussion Papers
Number 1077, April 2013 --- Screen Reader
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On Returns Differentials

Stephanie E. Curcuru, Charles P. Thomas, and Francis E. Warnock

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Abstract:

Estimates of U.S. returns differentials have ranged from exorbitant to quite small, in part because of their
volatility coupled with the relatively short time series available. We shed light on underlying drivers of
returns differentials by presenting a number of decompositions: a by-asset-class decomposition into yields
and capital gains, the Gourinchas and Rey (2007a) composition and return effects, and further
decompositions of capital gains that focus on exchange rate effects. While each decomposition informs
thinking about returns differentials, one constant is evident throughout: to date the existing differential
favoring the U.S. has owed primarily to one factor, a differential in direct investment yields. We discuss
how our analysis informs the income puzzle (of positive net income flows to the U.S. even as its net
international investment position is negative and substantial) and the position puzzle (of a sizeable gap
between the reported U.S. net international position and cumulated current account deficits), provide an
initial assessment of the literature on the dynamics of returns differentials, and present a framework to
guide a forward-looking view of how returns differentials might evolve in the future.

1. Introduction

The U.S. returns differential--that is, the difference between
the rate of return earned by U.S. residents on their foreign assets
and that received by foreign investors on their U.S. assets--is at
the heart of two puzzles in international macroeconomics, both
depicted in Figure 1. The first is the position puzzle: The U.S.
net international investment position (IIP) is far less negative
than the large and persistent U.S. current account deficits would
suggest (i.e., the reported IIP is less negative than cumulated
current account deficits), leading Obstfeld (2012) to ask whether
the current account is still meaningful. The second is the income
puzzle: Even with a substantial, negative IIP, on net the US
earns income on its net international position (i.e., the
income balance is positive). Moreover, not only is U.S. net
international income positive--it amounted to $235 billion in
2011--but over time it has improved even as the net investment
position has deteriorated. These puzzles raise several obvious
questions: Is the U.S. IIP much worse than reported? Does the US
have outsized earnings on its foreign positions? Are foreigners
such bad investors that their U.S. positions earn substandard
returns? When will the U.S. income balance finally turn negative
(and how in the world can it be positive)? And, as Obstfeld asked,
Is the current account even a meaningful measure? The answers to
all of these questions, as well as an understanding of the two
puzzles, hinge to at least some extent on return differentials.

Unfortunately for the lay person, the literature on returns
differentials is quite confusing. Two waves of research prior to
the recent financial crisis produced very different estimates of
returns differentials. The first wave backed international returns
out of IIP and flow data and found very large differentials in
favor of the US, differentials that exceed three percent per year.
In the second wave either data issues from the first wave were
addressed or direct readings of returns were used. These
adjustments showed that for overlapping time periods the first-wave
estimates of capital gains differentials were far too high, biasing
upwards the average U.S. returns differential by a few hundred
basis points. Then the pendulum swung partly back during the crisis
when some papers in a third wave produced differentials that were
as large as those in the first wave.

We aim to alleviate confusion surrounding returns differentials
in four steps. Step one is the categorization and analysis of the
three waves of literature on returns differentials. Our assessment
of the literature points to direct investment (DI) yields as
the primary source of whatever returns differential exists, so the
second step is an examination of the literature on the source of
the DI yield differential. In the third step we explore
implications of our analyses of the overall differential and DI
yields to shed light on two puzzles (the income and position
puzzles) and frame the nascent literature on the dynamics of
returns differentials. The fourth step synthesizes the takeaways
from the first three steps to form forward-looking estimates of
returns differentials (and the IIP and income balance), estimates
that readers can alter by adjusting some basic underlying
assumptions.1

Before starting, it is useful to lay out some terminology. While
it is unusual to do so in the introduction of a paper, this topic
requires precise language.

Total Returns are comprised of two components,
Yield and Capital Gains. Yield is the return
attributable to income streams (e.g., coupon payments, dividends,
earnings on DI), whereas capital gains are the returns attributable
to price movements (including exchange rate movements). We will be
exact in our use of these terms. If we write "yield", we are
referring to the returns attributable to income streams, not
capital gains. If we write "returns", we are referring to total
returns (unless we include the modifier "capital gains").

Returns differentials, which can describe differentials
in yield, capital gains, or their sum, can be decomposed into three
components: the composition, return, and timing effects. The first
two--the composition and return effects--capture average
characteristics of U.S. cross-border claims and liabilities. The
composition effect is positive if U.S. claims on foreigners
are weighted toward asset classes with higher average returns;
Gourinchas and Rey (2007a) showed convincingly that there is a
positive composition effect for the US. The return effect,
at the heart of the exorbitant privilege view, is positive if U.S.
investors earn higher average returns within each asset
class.2 The timing effect, the focus of
Curcuru, Dvorak, and Warnock (2010), is driven by reallocations
among different asset classes and captures the covariance between
current weights and subsequent returns; foreigners' returns in the
US are degraded by poor timing when switching between bonds and
equities.

With these definitions, we note that discrepancies in the
literature tend to be about different views of the return
effect (whether U.S. investors earn higher within-asset-class
average returns on their foreign portfolio than foreign investors
earn in the US). The forces behind the Gourinchas and Rey (2007a)
composition effect are not controversial. It is clear that
U.S. foreign assets are weighted toward equity and DI, whereas
foreigners' U.S. assets are weighted toward bonds. While the forces
behind the composition effect are undisputable, whether the effect
favors the US is sample dependent. If equities tend to outperform
bonds, the composition effect will be positive for the US. Over
some (rather lengthy) periods bonds have outperformed equities;
over those time periods the composition effect can be negative for
the US. For the timing effect, to date there is only one estimate
of roughly 50 basis points per year in favor of the US (Curcuru,
Dvorak, and Warnock 2010).

Our assessment of the returns differentials literature begins in
Section 2, where we distinguish between the three waves of research
on average returns differentials, mentioned above. At the end of
the third wave, officials at BEA weighed in: The current vintage of
IIP data should not be used to back out returns. We show that when
returns are calculated carefully the capital gains differential is
small (about 0.5%) and entirely due to a composition effect (rather
than a return effect), and that the overall differential is almost
entirely due to DI yields.

If whatever differential exists is due to a differential in DI
yields, then discussions of U.S. returns differentials should focus
more on DI and less on asset classes such as portfolio equity and
debt for which the differentials are inconsequential over the long
run. Thus, in Section 3 we discuss the literature on the DI
differential, a literature that attributes the wedge between yields
on U.S. direct investment abroad (USDIA) and foreign direct
investment in the United States (FDIUS) to differences in taxes,
risk, and age. Part of the DI yield differential is hard-wired:
USDIA earnings reported in the Balance of Payments (BOP) are not
net of the U.S. taxes paid on those earnings, whereas FDIUS
earnings are reported after taxes. There are also strong incentives
for U.S. firms to book earnings not at home, where corporate taxes
are high, but abroad in low-tax jurisdictions, thus deferring some
of the U.S. tax liability. These tax issues add up to 1.8% per year
to USDIA yields. A conservative adjustment, based on CDS spreads,
for the relative risk of investing outside the US accounts for an
additional 0.9%. Finally, young firms face start-up costs and often
use accelerated depreciation schedules, depressing reported
earnings; the relative youth of FDIUS explains about 1.5% of the DI
yield differential. Together, taxes, risk, and age explain much of
the DI yield differential.3

In sum, while before the crisis some estimates suggested that
there was a large returns differential that favored U.S. investors,
more recent evidence indicates that the U.S. returns differential
averages not 3-4% per year, but more like 1.5-2%, owing primarily
to a roughly 5% differential in DI yields. A literature that
has evolved over three decades shows that age, taxes (in part due
to a pre- and post-tax difference in reporting norms), and risk
explain that differential. And, while a sizeable 2% aggregate yield
differential exists (mostly in DI), the aggregate capital gains
differential is small, averaging only 0.5% per year, and is
entirely due to the composition effect. As is also shown in Section
3, over relatively short periods fluctuations in the exchange value
of the dollar substantially impact capital gains differentials.

In Section 4 we explore implications for the income and position
puzzles, as well as for the nascent literature on the dynamics of
returns differentials. Our analysis implies that the U.S. net
income puzzle--that the US on net earns positive income on its
negative $4 trillion net external position--is also the result of
the relatively high yield earned on USDIA. The position puzzle--the
large gap between reported net liabilities and those that would be
implied by past current account deficits--appears to be the result
of large statistical discrepancies between the current and
financial accounts rather than large average returns differentials.
In short, the income puzzle is no puzzle--it owes to a DI yield
differential, much of which is easily explained--and a large part
of the position puzzle owes to a disconnect between the data
collection systems for flows and positions. Finally, for the
important new literature on the dynamics of returns differentials,
we caution that while long time series are desirable, relatively
recent data are more accurate because of the many improvements to
data collection in recent years.

We close, in Section 5, with a forward-looking discussion of
U.S. returns differentials and their impact on the IIP and income
balance, a discussion that is centered on projections through 2025.
A number of interesting points emerge from this forward-looking
analysis. First, even if we impose a zero return effect--that is,
we keep capital gains returns differentials near their long-term
average of near-zero within each asset class--the composition
effect will be a stabilizing force on the net investment position.
Because U.S. claims contain a relatively high share of equity,
which has higher capital gains returns than other asset classes,
there will be a positive capital gains returns differential that
will keep the U.S. IIP from declining as fast as cumulated current
accounts. Second, this stabilizing force will likely be offset, in
part, by changes in the net income balance, which will put downward
pressure on the U.S. current account. If interest rates increase
toward their long-term averages, the net income balance will
decline because U.S. claims are much less heavily weighted toward
debt than liabilities. Third, the more benign case of continued
current account deficits but a stable net IIP is easy to depict. A
return effect of 2 percent would do the trick.

This article can inform several strands of the literature. It
informs the literature on the valuation effect of the current
account (see, among many others, Devereux and Sutherland 2010). An
important distinction in that literature is whether valuation
effects are anticipated or unanticipated. To rule on that, as
Devereux and Sutherland do, requires an accurate measure of returns
differentials. Our work also directly informs the global imbalances
literature. For example, the theoretical models in Mendoza,
Quadrini, and Rios-Rull (2009) and Mendoza and Quadrini (2010) are
in line with Curcuru et al. (2008) and this paper, in that they
imply that the excess return for the US comes out of the
composition of the U.S. external portfolio (that is, the
composition effect of being short in riskless assets and long on
risky ones) rather than any ability to produce higher yields on
seemingly homogeneous assets (a returns effect). Empirical
regularities impact what theory is written and, of that, which gets
an audience, so it is important to get the regularities right; were
such models inconsistent with the perceived empirical regularities,
they may well be shunned. Finally, our work influences the way we
think about the income and position puzzles. We show that these are
not actually puzzles, but well-understood regularities in the data.
This is an important distinction. Puzzles are something to explain
and then move on. In contrast, regularities--especially those that
involve significant magnitudes--must be accounted for in subsequent
work.4

2. The Returns Differential Literature: Three Waves and an
Assessment

2.1 The First Wave

The first wave of the returns differential literature occurred
during the pre-crisis Great Moderation period. The main papers are
Lane and Milesi-Ferretti (2005), henceforth LMF1; Gourinchas and
Rey (2007a), henceforth GR1; Meissner and Taylor (2006, MT); and
Obstfeld and Rogoff (2005, OR). This first set of papers--probably
with GR1 and LMF1 leading the way and MT and OR following--used
readily available (revised) series to calculate an implied returns
differential. The total return on U.S. claims or liabilities can be
calculated as follows:

(1)

where ARt is the position (claims or liabilities) at the
end of period t, FLOWRt is flows (U.S. flows abroad
or foreign flows into the US) during period t, and
INCRt is income (interest, dividend, and DI earnings) during
period t. The superscript R denotes revised,
indicating that all variables are of the latest vintage. The first
term in (1) is
returns owing to capital gains, while the second term is the income
yield.

Estimates of the yield (the second term in (1)) do not tend to
vary much across researchers. But there are substantial differences
in estimates of average capital gains (the first term) and, more
precisely, the dollar amount of valuation changes (the numerator of
the first term). Call that Val (for valuation changes):

(2)

The logic behind (2) is
straightforward. For any account, if the starting balance
(At-1), the ending balance (At), and the
contributions made between the start and end dates (Flowst)
are known, investment gains or losses (Valt) can be readily
calculated. Given Valt, percentage (capital gains) returns
are:

KG Returnst = 100 * Valt / At-1

(3)

The first wave of research on external returns applied this
logic to U.S. IIP data. In that context, A is the U.S.
international position and Flows are U.S. net capital
outflows. In theory, one could use (1) - (3) to produce an
estimate of the returns the US is earning on its international
assets and liabilities. This is exactly what was done in the first
wave of papers, which produced estimates ranging from 2.7% to 3.7%
per year favoring U.S. claims (Table 1). Returns computed using
(1) - (3) seem to
indicate that in every asset class U.S. investors abroad manage to
outperform foreign investors in the US, and much of the favorable
differential results from higher capital gains rates.

The problem that the first wave of papers did not anticipate is
that in practice (2) cannot be used
to compute a reasonably accurate estimate of Val, and thus
there is no basis for applying (3). The reason is
that A and Flows, which have completely different
revisions policies and come from different data collection systems,
are not consistent with one another. In the IIP data it need not be
the case that Flows plus Val are equal to the change
in A. This contrasts sharply with normal accounts, in which
contributions plus investment gains/losses should equal the change
in the balance.

In the IIP this inconsistency between A and Flows
is represented by an "other changes" term, OC, which is
similar in spirit to the statistical discrepancy in the
BOP.5 Including OC as part of the
change in A:

At = At-1 + Flowst+ Valt +
OCt

(4)

and the first wave of papers can be seen as computing implied
(capital gains) returns using not Val but Val +
OC:

KG Returnst = 100 * (Valt + OCt) /
At-1

(5)

Applying (5)
produces rather large returns differentials favoring U.S. claims on
foreigners because, as it turns out, in the U.S. IIP presentation
OC has been on average more positive for U.S. claims than
for U.S. liabilities. This is not an artifact of the older sample
period. Even in the current vintage of data (i.e., recent data that
incorporate all past revisions) OC is on average positive
for the US and drives the return differential strongly in favor of
the US6

One possible takeaway from the first wave of papers is that the
U.S. net debt position, while quite negative, was more benign than
thought because the US earned such large returns on its foreign
positions and paid foreigners very little on their U.S.
positions.

2.2 The Second Wave

A second wave of papers, written in the pre-crisis period but at
a time of increasing talk of a coming U.S. BOP crisis, realized
that including OC in valuation adjustments might lead to an
overestimate of U.S. returns differentials. The second wave
consisted primarily of Lane and Milesi-Ferretti (2009, LMF2);
Curcuru, Dvorak, and Warnock (2008, CDW); and Curcuru, Thomas, and
Warnock (2009, CTW). LMF2 shines the light on OC and
carefully assesses how much might be attributed to true VAL
and how much might be discrepancies in the data. CDW identifies the
main sources of the OC--inconsistent position and flow data
resulting from disparate revisions policies affecting different
items in the accounts--then constructs an estimate of the returns
differential after removing this inconsistency.

Compared with the estimates computed in the first wave of
papers, both LMF2 and CDW provide substantially lower estimates of
the capital gains portion of the U.S. returns differential (Table
2), even for overlapping time periods. CDW estimates that the
average capital gains differentials for debt and equity were 0.2%
and -2.3% per year, respectively; their combined differential was a
relatively modest 0.7% per year. LMF2 estimates that the aggregate
capital gains differential is only 0.6% per year--about one-fifth
the magnitude of the estimates in the first wave of papers.

LMF2 and CDW both end in a puzzle: If average returns
differentials are smaller, there is a disconnect in the
international accounts. If OC represent missing net outflows
rather than valuation adjustments, where are the offsetting inflows
needed to balance the BOP? CTW addresses this disconnect by
investigating various known holes in the accounts and finds that
some of the needed offsets might be explained by under-reporting of
U.S. exports and the omission of foreign purchases of U.S. real
estate from the international accounts. However, some of the puzzle
remains.

We place a fourth paper in the second wave--Gourinchas and Rey
(2007b), henceforth GR2--because it did not use (1)-(3) to compute
returns, but rather relies on market returns (similar to the CDW
approach). Note that GR2 report total returns, whereas the others
in Table 2 are capital gains returns, so there is a disconnect in
our table. But as can be seen in the table, GR2 produces modest
returns differentials. Given that yields are generally in favor of
the US (as we show in the next subsection), the U.S. aggregate
capital gains returns differentials implied by GR2 total returns
are quite negative.7

Comparing the first and second waves of papers, one might
conclude that there appeared to be an exorbitant privilege, but
that it was largely a function of statistical oddities, and when
direct readings of returns are used U.S. capital gains returns
differentials are positive but near zero.8 But then came a third
wave of papers.

2.3 A Third Wave

Whereas the second wave of papers produced very low average U.S.
returns differentials, a third wave--Forbes (2010), Habib (2010)
and Gourinchas, Rey, and Govillot (2010, GRG)--produced a range of
estimates, reported in Table 3. Several of these estimates are
quite large: Forbes (2010) uses the CDW methodology and finds a
very high returns differential: 6.9% excess returns per year during
2002-2006. Habib (2010) finds U.S. excess returns of about 3.4% for
the period 1981-2007; that most of the differential comes from
capital gains; that no other country in a broad panel has a
similarly large differential; and, consistent with GR1, that most
of the U.S. returns differential comes not from a composition
effect but from a within-asset-class return differential. GRG
provides two estimates, one of which updates and improves the GR1
dataset, confirms the GR1 results, and highlights a long-term
average returns differential of 3.5% per year from 1973-2009 (GRG
Table 1, Panel a).

How do these third wave estimates square with the previous
literature? Forbes found a high differential, but the very short
sample is at a time when the dollar was depreciating (which adds to
any underlying differential). Indeed, owing primarily to dollar
depreciation, the period studied in Forbes (2010) was one of
abnormally high differentials favoring the US (Figure 2).9 Forbes
also reports returns with exchange rate movements stripped out;
excluding exchange rate movements, the returns differential for the
asset class at the heart of the exorbitant privilege
view--bonds--is very small at only 0.3%. Although Habib (2010)
acknowledges the findings of the second wave of literature, it uses
equation (5)
to calculate returns.

Two other estimates of returns differentials in the third wave
were more modest. GRG also estimates the returns differential after
removing the OC. The result is an aggregate differential of
1.6% per year (GRG Table 1, Panel b), and the differential drops
dramatically for each asset class. Statisticians from the Bureau of
Economic Analysis (BEA) also weighed in. Gohrband and Howell
(forthcoming, GH) estimate an average returns differential of 1.7%
per year from 1990 to 2005 (GH Tables D and E), of which 1.2% is
from income yield and only 0.5% is from capital gains. GH
differentials are very similar to those calculated by the second
wave of papers, but much smaller than those from the first
wave.

The lower returns differentials in these latter papers stem from
their treatment of "other changes" (OC). To address the
issue of how much of the OC to include in Val, GH
states:

"Other changes" are changes in position that cannot be
attributed to price changes, exchange rate changes, or financial
flows . . . it is unlikely that significant price or exchange rate
changes have been erroneously included in "other changes" . . .
It is far more likely that financial flows that could not be
identified from revisions to position estimates have been
commingled with statistical changes in the "other changes"
category.10

Thus, the guidance from BEA--the compilers of data used in all
three waves to estimate the size of the returns differential--is
clear: OC likely represent unrecorded flows, and therefore
should not be included in the valuation adjustments used to
calculate the returns differential.11 Therefore the best
estimate of the returns differential is a relatively modest, but
still significant 1.6-1.7% per year.

3. What Drives the Returns Differential?

3.1 Our Preferred Estimates of Returns Differentials,
1990-2011

To understand the drivers of whatever returns differential
exists, we (i) follow BEA's lead and update the GH estimates
through 2011, separating out capital gains from yields, and (ii)
lean on the GR1 insight that the overall differential is usefully
decomposed into two components, the within-asset-class returns
effect and the across-asset-class composition effect.12

As the second wave of papers made clear, discrepancies in
estimates of returns differentials owed in large part to past BEA
policies of regularly revising positions, rarely revising flows,
and never publicly releasing revisions to valuation adjustments.
This changed, to some extent, with GH, which provides data on
revised valuation adjustments for the components of the IIP--data
that were previously unavailable to researchers. In what follows
the underlying returns are formed using the GH data (available
through 2005) and their recipe to calculate returns through 2011.
Annual averages are presented in Table 4, with the GR1
decomposition of the differential into the returns and composition
effects at the right side of the table.

Two insights are immediately evident from Table 4. First, a 6.1
percent differential in FDI yields is responsible for the bulk of
the 1.9% overall (annual) differential for the 1990-2011
period.13 Second, in the decomposition into
return and composition effects, the return effect--specifically,
its yield component--accounts for almost the entire differential
for that period. Over the past two decades capital gains
differentials are small (0.4%) and, as shown in the decomposition
of capital gains, on average almost entirely due to fluctuations in
prices rather than exchange rates.

Whether the overall returns differential is decomposed into
yields and capital gains by asset class or into the underlying
return and composition effects, one thing emerges: To understand
the returns differential, we must turn to yields, and DI yields in
particular.

3.2 On the DI Yield Differential

Based on the most recent and improved estimates the returns
differential in favor of the US is about 2%, and, as depicted in
Figure 3 (and Table 4), owes primarily to a large advantage in DI
income yields. In contrast, the income yields for other asset
classes and capital gains for all asset classes (including DI) are
virtually indistinguishable for claims and liabilities.14 This
suggests that any discussion of the average size of the U.S.
returns differential should focus primarily on DI, specifically on
the earnings U.S. firms book on their foreign operations relative
to the earnings foreign firms book on their U.S. operations.

That U.S. firms earn more on their foreign operations than
foreign firms earn on their U.S. operations--shown graphically in
Figure 4--has been known for decades and is the subject of several
papers (Lupo et al. (1978), Landefeld et al. (1992), Mataloni
(2000), Gros (2006), Bosworth et al. (2008), McGrattan and Prescott
(2010), Curcuru and Thomas (CT, 2012)). The gap between the USDIA
and FDIUS yields averaged 5.6% per year from 1983 - 2010 (first
line of Table 5). To shed light on this gap, we next summarize the
evidence on the role of factors for which time series estimates can
be formed (taxes, risk, and age) and other factors for which time
series estimates are more difficult to form (transfer pricing,
industry mix, and intangibles).

3.2.1 Taxes

As discussed in CT, some of the difference between USDIA and
FDIUS yields is a hard-wired illusion of BOP accounting, because
BOP-reported USDIA earnings are to some extent pre-tax while FDIUS
earnings are after-tax (i.e., after the deduction of U.S. taxes).
For USDIA, BOP-reported earnings are indeed net of foreign
taxes, and the U.S. parent earns credit for some of the foreign
taxes it pays, but the parent usually still owes a substantial
amount of U.S tax on repatriated earnings because the U.S. tax rate
is generally higher. The U.S. taxes paid by U.S. parents on their
foreign-generated income are not subtracted from BOP-reported
cross-border income receipts because the tax is paid by the U.S.
parent firm and is not a cross-border transaction. Because the
reported USDIA earnings yield is net of (the usually low) foreign
taxes but does not net out U.S. taxes, reported data tend to
overstate the after-tax earnings of the U.S. parent firm on their
foreign investment. U.S. taxes on repatriated earnings accounts for
an average of 0.8 percentage points of the USDIA earnings yield
(Table 5, row 2). U.S. taxes that might (or might not) eventually
be paid on reinvested earnings account for an additional 1.0
percentage point (Table 5, row 3). These estimates of actual and
potential repatriated earnings are consistent with the Bosworth et
al. (2008) estimate that the diversion of income to low-tax
jurisdictions accounts for 1-1.5 percentage points of the USDIA
yield.

3.2.2 Risk

Some of the wedge between USDIA and FDIUS yields can plausibly
represent compensation for the additional risk associated with
investing abroad. USDIA is disproportionately in emerging markets,
and Hung and Mascaro (2004) estimate the average credit rating of
USDIA investments was BBB by weighting country sovereign credit
ratings by USDIA investment shares. They estimate the average risk
compensation included in USDIA yields was 1.4 percentage points
between 1999 and 2003, the average difference between AAA and BBB
spreads over this time. CT used CDS spreads and arrived at more
modest estimate of risk compensation averaging 0.9 percentage
points per year (Table 5, row 4), bringing the total adjustments
for taxes and risk to almost 3 percentage points per year.15

3.2.3 Age

The literature consistently reports that FDIUS underperforms
other domestic operations and USDIA, despite the widespread belief
that these earnings yields should be similar. However, this
literature finds that a significant portion of the earnings yield
differential is related to age (Lupo et al. (1978), Landefeld et
al. (1992), Grubert et al. (1993), Laster and McCauley (1994),
Feldstein (1994), Grubert (1997), Mataloni (2000), McGrattan and
Prescott (2010), CT). FDIUS affiliates are generally younger than
USDIA affiliates or U.S. domestic operations. Younger firms have
relatively high expenses because of restructuring and other
start-up costs, as well as accelerated depreciation schedules for
fixed assets. These higher expenses lead to low initial earnings
yields that disappear as firms age. Further, retained earnings
eventually replaces external financing as the major source of
capital as affiliates age, which also results in lower expenses and
higher yields (Feldstein 1994). Finally, as McGrattan and Prescott
(2010) demonstrate, over time firms can accumulate significant
intellectual and brand capital, which raises earnings, but is not
included in the measured capital stock or flows. CT finds that
relative youth lowers the FDIUS yield by an average of 1.5
percentage points per year (Table 5, row 5). In sum, the
adjustments for taxes, risk, and age reported in Table 5 account
for much of the DI yield differential, totaling 3.2 - 4.2
percentage points per year (with the low estimate assuming that no
earnings currently abroad are ever repatriated).

3.2.4 Other Factors

Other factors influencing the difference between USDIA and FDIUS
yields include transfer pricing, industry mix, and intangibles.
While many studies have examined the role of transfer pricing--that
USDIA yields are artificially high or FDIUS yields are artificially
low because of favorable inter-firm pricing of goods or
services--most find no effect (Laster and McCauley (1994), Grubert
(1997), Mataloni (2000)). However, more recent work by Bernard et
al (2006) finds some evidence of transfer pricing. This study,
which examines detailed price and transaction data on U.S. exports,
finds that the prices of exports to related firms are
systematically lower than exports to unrelated firms, and the
difference is strongly related to foreign tax rates. This
mispricing will have a downward effect on the earnings of
multinational firms located in the US and an upward effect on the
earnings of multinational firms located abroad. Unfortunately firm
nationality is not reported in the customs data used in that study
so a direct link to USDIA or FDIUS earnings cannot be made.
However, after making assumptions on the magnitude of the
mispricing that might be attributed to USDIA vs. FDIUS firms, CT
estimates that favorable transfer pricing might account for 80
basis points of the 480 basis point difference between USDIA and
FDIUS yields in 2004.16

While the industry mix of FDIUS is dramatically different than
USDIA and U.S. investment more generally, Mataloni (2000) finds
that the return on FDIUS assets was below that of U.S. operations
for most industries and did not find evidence of industry effects.
Similarly, Hung and Mascaro (2004) find no difference in the
relative risk of the industry composition of outward and inward
U.S. DI investment.

Other work suggests that differing amounts of investment in
intangible capital (defined in Bridgeman (2008) as patents,
trademarks, trade secrets, and organizational knowledge) is
responsible for the large difference between FDIUS and USDIA
yields. The value of intangible capital is excluded from BEA's
current-cost valuation method for DI because of measurement
difficulties.17 Bridgeman (2008) estimates the
stocks of intangible assets and finds that including them in the
USDIA and FDIUS positions reduces the gap between USDIA and FDIUS
yields by three-fourths. McGrattan and Prescott (2010) suggest that
the low FDIUS yield reflects the large amount of research and
development investment these firms engage in, which is accounted
for as an expense; in their model, intangible capital accounts for
over half of the difference between USDIA and FDIUS yields during
their sample period.18

3.2.5 Summing Up: Factors Behind the DI Yield
Differential

Most of the wedge between yields on USDIA and FDIUS is well
explained by differences in taxes, risk, and age. USDIA earnings
reported in the BOP are not net of the U.S. taxes paid on those
earnings, and there are strong incentives for U.S. firms to book
earnings not at home, where corporate taxes are high, but abroad in
low-tax jurisdictions so some of the U.S. tax liability is
deferred. These tax issues add up to 1.8% per year to USDIA yields.
An adjustment for the relative risk of investing outside the U.S.
accounts for an additional 0.9%. And the relative youth of FDIUS
explains about 1.5%. While transfer pricing, differences in
industry structure, and intangibles likely matter, much of the DI
yield differential can be explained by taxes, risk, and age.

3.3 The Exchange Value of the U.S. Dollar

Over relatively short periods, movements in the US dollar have
strong effects on returns on U.S. foreign assets (when translated
back into dollars). Foreign currency appreciation increases U.S.
returns on foreign assets; dollar appreciation decreases them. This
is highlighted in Table 6, where the sample is split into two
periods: 1990-2000 (a period when the dollar largely appreciated)
and 2001-2011 (when the dollar largely depreciated). The two
periods differ not in yields--over the last two decades the yield
differential has averaged 1.4% with little variation (1.4% for
1990-2000 and 1.5% for 2001-2011)--but in capital gains. The
capital gains differential, -0.5% for 1990-2000, was 1.2% over the
past decade, owing to a substantial capital gains differential on
equity positions.

Table 6 also provides more information on source of the capital
gains differential. In the 1990s, abstracting from currency
returns, aggregate U.S. assets and liabilities performed similarly;
the aggregate "price" differential was 0.1%. The -0.5%
differential on capital gains during that period owed entirely to
dollar appreciation; the differential owing to exchange rate
changes was -0.6%. In contrast, in the past decade the
positive 1.2% differential on capital gains was split between price
and currency differentials. Equity markets in the US and elsewhere
performed poorly, but foreign markets performed slightly better
(1.7% annual return, versus 0.8% in the US). Just as importantly,
the dollar depreciated against most currencies, adding to the
returns on U.S. claims.

Our takeaway from Table 6 is that over the past two decades the
yield differential has been both important and relatively stable at
about 1.5% per year (mostly due to the DI yield differential) and
that the capital gains differential has been more volatile,
depending in part on fluctuations in the exchange value of the
dollar. This volatility occurred in every asset class, and is
likely to continue.

4. Implications for Two Puzzles and the Dynamics of Returns
Differentials

4.1 Implications for the Income and Position Puzzles

Two puzzles, both highlighted in Obstfeld (2012), were depicted
in Figure 1: the income puzzle that the U.S. receives, on net,
income payments on its international investment position even
though the investment position is very negative, and the position
puzzle of a large gap between the reported IIP and cumulated
current account deficits. In this section we use evidence from the
preceding sections to shed light on both puzzles.

4.1.1 The U.S. Net Income Puzzle

U.S. net income on its international positions is positive even
though it is a net debtor because of the net income it receives on
DI. As Figure 5 shows, U.S. net income has averaged $90 billion per
year during the past decade. Net DI income more than accounted for
the aggregate amount, averaging $190 billion per year. On other
types of international investments, U.S. net income has averaged
negative $100 billion.

Figure 6 shows this another way. If the yields on cross border
claims equaled those on liabilities, income would be negative and
trending down with the position; this counterfactual is depicted by
the dotted line in the figure. If yields on everything except DI
were as reported, but we constrain DI yields on assets to equal
those on DI liabilities, income would still be negative until 2011
(the dashed line).19 Over the 1990 to 2011 period, the
cumulated dollar value of the gap between aggregate reported net
income and net income with equal DI yields is $2.3 trillion, or 60%
of the total net recorded liability position.20 This illustrates
an important point: Although the total returns differential is
relatively small, it nonetheless generates a significant net wealth
transfer to the US.21

The unusually high yield on USDIA has been the main driver of
the net income puzzle. As discussed earlier, some of this owes to
different treatments of taxes in the international accounts. For
the 2000-2010 period, aggregate net income averaged $90 billion per
year. An upper estimate is that differential tax treatment
accounted for $64 billion of that.22 If not for the fact
that BOP-reported USDIA earnings are to some extent pre-tax while
FDIUS earnings are after-tax (i.e., after the deduction of U.S.
taxes), the aggregate net income balance would be much smaller,
roughly $20 billion per year for 2000-2010. But even after
adjusting for taxes, net income is positive, and considering how
large and negative that the U.S. international position is, this
alone is enough to have macro implications. Because taxes and risk
play a large role in USDIA's unusually-high yield, unless there is
a change in relative tax rates or the relative riskiness of
investing in the US vs. abroad, net investment income should
continue to be a significant stabilizing force for the U.S. current
account deficit.

4.1.2 The Position Puzzle

Also depicted in Figure 1 was the position puzzle, the large gap
between the reported IIP and cumulated current account deficits.
Were the U.S. capital gains returns differential large, the puzzle
would be explained, but the weight of evidence suggests that the
capital gains returns differential is rather small. As noted by
LMF2 and analyzed at length in CTW, low estimates of the U.S.
capital gains differential leave us with a very large gap between
reported net liabilities and those that would be implied by past
current account deficits and measured capital gains rates.
Cumulating from 1990, CTW estimated this gap to be $1.7 trillion as
of 2007. Rather than closing the gap by adding these other changes
to the valuation adjustments, as was done in the first wave of
literature, GH suggests that these are missing flows, which should
be included in the statistical discrepancy. This implies that what
has been previously presented as a returns puzzle is more likely a
missing flows puzzle.23

CTW attempted to close the gap by addressing three types of
known weaknesses in the U.S. international accounts. First, some
assets are not captured in the historical financial accounts data.
These include residential real estate, which should be in the
direct investment data, and financial derivatives, introduced only
in 2006. Second, some items (IPOs, asset-backed repayments, goods
exports) have known shortcomings in the transactions data in the
current and financial accounts but have no known accompanying flaws
in the positions data. Third, some items (short positions, direct
investment in intangibles) have known shortcomings in the positions
data but for which the associated transactions data are thought to
be sound. CTW developed reasonable plugs to these holes, and was
able to narrow the $1.7 trillion gap to $370 billion. However,
their reconciliation resulted in a positive statistical discrepancy
in the BOP of roughly $500 billion ($30 billion per year),
representing additional unaccounted net inflows, at a time when the
cumulated reported statistical discrepancy was only $32
billion. The CTW estimates of the statistical discrepancy--formed
as a residual after plugging some known holes in the U.S. data
collection system--were greatly at odds with reported
statistics.

In Figure 7 we update the CTW gap analysis. As the figure
depicts, using updated GH returns and a statistical discrepancy
that is part reported and part updated CTW, the resulting gap is
fairly small. It appears that a small returns differential might
indeed be consistent with reported BOP and IIP data, and that the
position puzzle is really a missing flows puzzle.

4.2 The Dynamics of Returns Differentials

Our survey has focused on average returns differentials.
A valid point is that our best estimates of the average U.S.
returns differential utilize only 22 data points, because some
vital data are not available prior to 1990. Returns differentials
are measured, not observed, so they are inherently estimates; prior
to 1990 too much of the data required to form the estimates is
unavailable. Indeed, in their assessment of the literature, GH
provided estimates only back to 1990.

The short time series available poses problems. Returns
differentials are volatile, so to form expectations of future
differentials (or even to confidently calculate the mean, the main
focus of this paper) one would want many more than just 22
observations. Likewise, to understand the volatility of returns
differentials or how they covary with US and global business cycles
requires more observations.

Another important literature--that on the dynamics and
information content of returns differentials--has moved forward by
creating more data points on returns differentials. Gourinchas and
Rey (2007b) found that returns differentials contribute 27 percent
of the cyclical external adjustment, and Evans and Fuertes (2011)
find that one-half of the variation in quarter-to-quarter changes
in the U.S. external position is due to revisions in expectations
concerning future returns differentials. Both findings imply
exchange rate predictability at horizons thought to be ruled out by
Meese and Rogoff (1983) and many subsequent papers.

We wonder, however, about the underlying returns differentials
series. One issue is the creation of quarterly data--increasing the
sample size by a factor of four--when positions data are available
only at the annual frequency. More important are substantial
differences in the dynamics of various returns differentials
series. Figure 8 shows that while annual returns differentials
fromGH and CTW are virtually indecipherable from one another,
differentials from GR1 are more positive (on average) and much more
volatile. GR2 differentials are much closer to the CTW and GH
series, although differences are evident, especially in the 1990s.
Evans and Fuertes state that over a short period (mid-90s to 2004)
their differentials are similar to those in CDW and, hence, not
subject to the data concerns raised inCDW, solidified inCTW, and
re-established in GH. At this point one must conclude that while
the accuracy of returns differentials is vital for this literature
to be on solid footing and all else equal more observations can
help, the accuracy of the underlying series is not yet clear. More
work on this issue is recommended.

5. A Post-Crisis View of the U.S. Returns
Differential

As our analysis has indicated, it is useful to decompose the
U.S. returns differential into its return and composition effects
(as in GR1) and also into yields and capital gains, with a further
decomposition of capital gains into its price and exchange rate
components.

In this section we make these decompositions more tangible by
highlighting their roles in projections through 2025 of returns,
net income and the net investment position. Our baseline
projections use the following assumptions: (a) capital gains rates
are 5 percent on equities (both claims and liabilities) and zero
for all other assets, (b) dollar depreciates by 0.15 percent in
2012--the actual change in the FRB's Major Currencies Index--and
then remains flat, (c) bond yields on both claims and liabilities
evolve according to changes in the Blue Chip Financial Forecast
from December 2012, increasing by 4 percentage points by 2019 then
remaining constant, (d) the yield on FDIUS claims increases by 1
basis point per year for a total increase of 1.4 percentage points
as the capital stock ages, (e) yields on other assets are held at
their long-term averages, (f) U.S. nominal GDP evolves according to
the Blue Chip Financial Forecast from December 2012, increasing by
an average 2.7 percentage points per year, and (g) the goods and
services deficit and net transfers deficit both increase by 1
percent per year, with capital flows increasing to offset the
resulting current account deficits (i.e., zero statistical
discrepancy).24

5.1 The Composition Effect

As GR1 noted, the composition of U.S. liabilities and assets
differ, with liabilities much more heavily weighted toward debt.
For decades equity outperformed debt, so it is natural to assume
that based on a composition effect U.S. asset returns would tend to
outperform U.S. liabilities. But during the crisis--and even for a
number of years pre-crisis--debt outperformed equity to such an
extent that since 1990 the composition effect is roughly zero
(Table 4). Going forward, if equity reasserts itself as a
well-performing asset class, we would expect the capital gains
aspect of the composition effect to increase. Offsetting this,
perhaps, would be the effect of a normalization of interest rates.
Were bond yields to increase, the yield portion of the composition
effect would become more negative.

Our baseline projections depict this scenario of an equity
premium and a normalization of interest rates. Returns
differentials are shown in Table 7; projections for net income and
the net investment position are in Figure 9.

For capital gains, the baseline scenario highlights the
composition effect. With a flat dollar and assumption (a) of no
returns differential in each asset classes (i.e., a zero price
return effect), the capital gains return effect is zero. However,
because of a 0.5 percentage point capital gains composition effect,
the overall capital gains returns differential is positive. The
overall returns differential is 1.9 percent, due in large part to a
1.3 percent yield differential that is largely driven by a 4.5
percent differential in DI yields.

The baseline scenario has striking implications for yields and,
by extension, the income balance and current account. Assumptions
(c)-(e) on yields produce a negative net income balance starting in
2016 (Figure 9), in large part because debt payments to foreigners
would more than double (and debt is a large portion of U.S.
liabilities). In this scenario--with a normalization of long rates,
continued trade deficits, no return effect, and a flat U.S.
dollar--the U.S. net IIP and cumulated current accounts both
deteriorate to 70 percent (or more) of GDP by 2025. The swing in
the income balance from positive to negative has a substantial
impact on the current account deficit. Even though the trade
balance improves from -3.7 percent of GDP in 2011 to -2.9 percent
in 2025 (because GDP grows a bit faster than the increase in the
trade deficit), the sharp decline in the income balance causes the
current account to deteriorate sharply from -3.1 percent of GDP to
-6.2 percent.

5.2 The Return Effect

The return effect has been driven by within-asset-class
differentials in yields, not capital gains (Table 4). In turn, the
large differential in yields owes to the large gap in FDI yields.
Quantifiable reasons behind this DI yield gap, discussed in Section
3.1 and presented in Table 5, include taxes, risk, and age. Unless
U.S. tax laws governing multinational firms change, we expect
differential tax treatment to continue to result in a yield gap in
favor of USDIA. The crisis does not change our thinking on this.
However, we expect this gap to narrow a bit because the return on
FDIUS should increase slightly as the investments mature.

We show an alternative scenario for the capital gains return
effect in Figure 10. Here we start with the capital gains from
Figure 9, in which capital gains on claims and liabilities in each
asset class were equal, but then add 2 percentage points to the
capital gains return for U.S. claims. In this case the capital
gains portion of the return effect is quite large--counter to
evidence from the past two decades--and even with continuing
current account deficits, the net IIP is stable because of the
growth in the claims position. The income yields in Figure
10 are the same as Figure 9, but the income balance remains near
zero because of the relatively fast growth of claims.

This is in essence the world as portrayed in the first wave of
the literature on returns differentials. With a 2 percent return
effect, the overall returns differential is 3.9 percent. The U.S.
income balance remains positive and, thus, even with continued
trade deficits the current account deficit would not deteriorate.
With the substantial return effect, the U.S. IIP would remain
stable.

5.3 The Exchange Value of the U.S. Dollar

Over the short- to medium-term, fluctuations in the dollar can
have a large impact on the capital gains differential. Prior to the
crisis many economists believed the dollar would continue to fall,
owing in part to the large and persistent U.S. current account
deficits. However, he crisis stalled the 7-year-long slide in the
dollar. Now, in 2013, while some fundamentals point to dollar
depreciation, there are some emerging longer-term factors that
should support the dollar. In particular, the sharp decline in net
imports of energy will, all else equal, provide some support to the
dollar. One given: in years the dollar loses value the U.S. returns
differential will be higher. This was highlighted in Table 6, which
showed that in the 1990s (when the dollar appreciated) FX capital
gains subtracted 0.6 percent per year from U.S. returns
differentials, whereas dollar depreciation since 2001 added 0.7
percent per year.

Our baseline dollar projection in Table 7 and Figure 9 is flat,
with no change from 2013 to 2025. If instead the dollar depreciates
by -0.5 percent per year through 2025, U.S. returns differentials
would increase by 0.5 percent to 2.4 percent, and this higher
returns differential would lessen the decline in the IIP. Another
dollar scenario is provided by the Blue Chip forecasts, which has
the dollar appreciating an average of 0.64 percent per year through
2018 and then roughly flat thereafter. The appreciation of the
dollar would result in a negative capital gains return effect and
lessen the overall return differential to 1.7 percent. As a result,
the IIP would deteriorate slightly faster.

6. Conclusion

In this paper we surveyed the literature on returns
differentials. The first wave of papers in this literature produced
differentials in favor of the US that are large enough that
"exorbitant" is an apt descriptor. The second wave recognized
that reported (and, especially, revised) IIP and BOP data could not
be combined to back out returns; this set of papers found much
smaller differentials. Some papers in a third wave found much
higher differentials, but then the BEA weighed in: Differentials
are small, with the exception of those for FDI yields. We show that
the FDI literature suggests the large yield differential owes to
adjustments for taxes, risk, and for the relative youth of FDIUS
firms.

One surprising result is that the Gourinchas and Rey (2007a)
composition effect is small over the past 22 years. This does not
mean it will not be important over the next 22. The composition of
U.S. assets and liabilities clearly differ, with U.S. liabilities
much more heavily weighted toward debt. Debt returns have fared
well vis-à-vis equity returns the past few decades, so there
has not been a positive composition effect for the US. If in the
future equity returns exceed debt returns, the composition effect
will again be important and will increase the U.S. returns
differential.

Our analysis informs two puzzles. The income puzzle--the fact
that U.S. net international income is positive (and growing) even
as its net IIP is negative (and becoming more so)--owes entirely to
the large (reported) earnings U.S. MNCs earn abroad relative to
what foreign MNCs earn in the US, a wedge well explained by issues
such as taxation and risk. The position puzzle--the fact that the
U.S. net IIP is far less negative than cumulated current account
deficits--is consistent with a relatively small returns
differential, large recent statistical discrepancies, and
adjustments along the lines of Curcuru, Thomas, and Warnock
(2009).

Our analysis also has implications for the nascent literature on
the dynamics of returns differentials and external positions. While
we fully agree that long time series of the highest frequency
possible are desirable for this literature, we caution that more
work should be done to ensure that the underlying series are
accurate.

Finally, we note that while it is tempting to compare returns
differentials across a range of countries, there are a number of
pitfalls researchers should be aware of. We highlighted some of the
difficulties in interpreting the differentials for a single
country. The same difficulties associated with statistical series
breaks, inconsistent data collection systems and out-of-sync
revision policies that give rise to influential "other changes"
in the U.S. IIP also exist for other countries.25 For example, for
the euro area OC average 0.5% per year 2000-2009. If one
ignores our caveats and computes returns for other countries via
equations (1)-(3), the resulting
differentials are much smaller than for the US and, indeed, often
negative (Habib 2010). Our unreported analysis using IMF data
reveals that portfolio returns differentials across countries are
similar to U.S. differentials (excluding OC), suggesting
that DI yield differentials are responsible for the difference
between the aggregate U.S. differential and that reported by other
countries. However, substantial differences in DI data definitions
across countries make comparisons difficult for more than a handful
of countries. 26 We caution against such analysis
unless one is willing to begin with an arduous data reconciliation
exercise.

Forbes, K., 2010. Why do foreigners invest in the United States?
Journal of International Economics 80(1), 3-21.

Gohrband, C., Howell, K., forthcoming. U.S. international
financial flows and the U.S. net investment position: New
perspectives arising from new international standards. In Charles
Hulten, Michael Palumbo, and Marshall Reinsdorf (editors),
Wealth, Financial Intermediation and the Real Economy (NBER
).

Gourinchas, P., Rey, H., 2007a. From world banker to world
venture capitalist: The U.S. external adjustment and the exorbitant
privilege. in R. Clarida (ed.) G7 Current Account Imbalances:
Sustainability and Adjustment (Chicago, Univeristy of Chicago
Press), 11-55.

Gros, D., 2006. Foreign investment in the US (II): Being taken
to the cleaners? CEPS Working Document No. 243, Centre for European
Policy Studies, Brussels, April.

Grubert, H., 1997. Another look at the low taxable income of
foreign-controlled companies in the United States. U.S. Treasury
Department, Office of Tax Analysis Paper 74 (October).

Grubert, H., Goodspeed, T., Swenson, D., 1993. Explaining the
low taxable income of foreign-controlled companies in the United
States. in Studies in International Taxation, edited by Alberto
Giovannini, Glenn Hubbard, and Joel Slemrod, 237-275. Chicago:
University of Chicago Press.

Lane, P., Milesi-Ferretti, G., 2009. Where did all the borrowing
go? A forensic analysis of the U.S. external position. Journal of
the Japanese and International Economies 23(2), 177-199.

Laster, D., McCauley, R., 1994. Making sense of the profits of
foreign firms in the United States. Federal Reserve Bank of New
York Quarterly Review (Summer-Fall), 44-75.

Lupo, L., Gilbert, A., Liliestedt, M., 1978. The relationship
between age and rate of return of foreign manufacturing affiliates
of U.S. manufacturing parent companies. Survey of Current Business
58, August, 60-66.

Mataloni Jr., R., 2000. An examination of the low rates of
return of foreign-owned U.S. companies. Survey of Current
Business80, March, 55-73.

Table 1: Returns Differential Estimates from the First Wave of Literature: Gourinchas and Rey (2007a)2:

Source

Period

Aggregate: Total

Aggregate: Yield

Aggregate: Capital Gains1

FDI

Debt

Equity

Other

Gourinchas and Rey (2007a)2: Table 1.1

1973-2004: Claims

6.8

-

-

9.7

4.1

15.5

4.1

Gourinchas and Rey (2007a)2: Table 1.1

1973-2004: Liabilities

3.5

-

-

9.3

0.3

9.4

1.2

Gourinchas and Rey (2007a)2: Table 1.1

1973-2004: Difference

3.3

-

-

0.3

3.7

6.1

3.0

Gourinchas and Rey (2007a)2: Table 1.2

1973-2004: Returns Effect

2.5

-

-

0.0

0.7

0.6

1.2

Gourinchas and Rey (2007a)2: Table 1.2

1973-2004: Composition Effect

0.9

-

-

0.7

0.2

0.0

-

Lane and Milesi-Ferretti (2005)3: Table 5

1995-2004: Claims

7.2

-

-

-

4.3

10.1

-

Lane and Milesi-Ferretti (2005)3: Table 5

1995-2004: Liabilities

4.5

-

-

-

2.1

9.9

-

Lane and Milesi-Ferretti (2005)3: Table 5

1995-2004: Difference

2.7

-

-

-

2.2

0.2

-

Obstfeld and Rogoff (2005): Text

1983-2003Difference

3.1

1.2

1.9

-

-

-

-

Meissner and Taylor (2006): Table 3 and 4

1981-2003:Difference

3.7

1.7

2.0

-

-

-

-

1Capital gains inferred from the difference between Total and
Yield differential.2Values are from Gourinchas and Rey (2007a) Tables 1.1 and 1.2.
In that paper they are labeled as real returns, although in the
associated file posted on the web
(http://socrates.berkeley.edu/~pog/academic/wb_data.xlsx) they
match series labeled nominal.3Values from Lane and Milesi-Ferretti (2005) are real returns
averaged over the three time periods in Table 5.
.. not available.

Table 2: Capital Gains Differential Estimates from the Second Wave of Literature

Source

Period

Aggregate

FDI

Debt

Equity

Other

Curcuru, Dvorak and Warnock (2008): Table II

1994-2005: Claims

..

..

6.1

9.6

..

Curcuru, Dvorak and Warnock (2008): Table II

1994-2005: Liabilities

..

..

5.9

11.9

..

Curcuru, Dvorak and Warnock (2008): Table II

1994-2005:Difference

..

..

0.2

-2.3

..

Lane and Milesi-Ferretti (2009)1:Table 7

1983-2007: Claims

2.1

0.6

0.8

10.3

..

Lane and Milesi-Ferretti (2009)1: Table 7

1983-2007: Liabilities

1.6

0.5

0.3

9.1

..

Lane and Milesi-Ferretti (2009)1: Table 7

1983-2007:Difference

0.6

0.1

0.6

1.2

Curcuru, Thomas and Warnock (2009)2: Table 1

1990-2007: Claims

2.3

1.3

2.0

8.2

2.8

Curcuru, Thomas and Warnock (2009)2:Table 1

1990-2007: Liabilities

1.1

0.5

0.6

9.7

0.0

Curcuru, Thomas and Warnock (2009)2: Table 1

1990-2007:Difference

1.1

0.8

1.4

-1.5

2.8

Memo: Gourinchas and Rey (2007b)3

1983-2004:Q1 Claims

6.8

8.4

8.5

10.4

5.5

Memo: Gourinchas and Rey (2007b)3

1983-2004:Q1 Liabilities

7.5

9.0

8.2

12.5

5.2

Memo: Gourinchas and Rey (2007b)3

1983-2004:Q1Difference

-0.7

-0.6

0.3

-2.1

0.3

1Capital gains from Lane and Milesi-Ferretti (2009) are
averaged over the three time periods in Table 7.2Curcuru, Thomas and Warnock (2009) aggregate and FDI capital
gains include the value of "other adjustments" for FDI.3Total returns for Gourinchas and Rey (2007b) , calculated from
http://socrates.berkeley.edu/~pog/academic/IFA_data.xls, are
average nominal total (i.e., yield plus capital gains)
returns and, thus, to make them directly comparable with the
capital gains returns in the rest of the table one would have to
subtract yields from them (about 1.0 - 1.5% for the aggregate).
.. not available

Table 3: Returns Differential Estimates from the Third Wave of Literature

Source

Period

Aggregate: Total

Aggregate: Yield

Aggregate: Capital Gains

FDI

Debt

Equity

Other

Forbes (2010)1 Tables 1, 2

2002-2006: Claims

11.2

-

-

16.3

6.7

17.4

-

Forbes (2010)1 Tables 1, 2

2002-2006: Liabilities

4.3

-

-

5.6

5.3

7.6

-

Forbes (2010)1 Tables 1, 2

2002-2006:Difference

6.9

-

-

10.7

1.4

9.8

-

Forbes (2010)1Excluding ER Changes

Changes: Claims

8.6

-

-

12.9

4.9

12.0

-

Forbes (2010)1Excluding ER Changes

Changes: liabilities

-

-

5.6

4.6

7.6

-

-

Forbes (2010)1Excluding ER Changes

Changes:Differnce

-

-

7.3

0.3

4.4

-

-

Habib (2010): Table 2

1981-2007:Difference

3.4

1.3

2.1

-

-

-

-

Gourinchas, Rey and Govillot (2010)2: Tables 1, 3 Panel a

1973-2009: Claims

6.3

-

-

-

-

-

-

Gourinchas, Rey and Govillot (2010)2: Tables 1, 3 Panel a

1973-2009: Liabilities

2.8

-

-

-

-

-

-

Gourinchas, Rey and Govillot (2010)2: Tables 1, 3 Panel a

1973-2009:Difference

3.5

-

-

5.0

4.7

4.2

0.2

Gourinchas, Rey and Govillot (2010)3 Tables 1, 3 Panel b

1973-2009: Claims

5.0

-

-

-

-

-

-

Gourinchas, Rey and Govillot (2010)3 Tables 1, 3 Panel b

1973-2009: Liabilities

3.4

-

-

-

-

-

-

Gourinchas, Rey and Govillot (2010)3 Tables 1, 3 Panel b

1973-2009:Difference

1.6

-

-

1.9

2.5

1.2

-0.9

Gohrband and Howell (forthcoming)4 Tables D, E

1990-2005: Claims

7.6

5.0

2.7

10.4

7.7

8.5

4.3

Gohrband and Howell (forthcoming)4 Tables D, E

1990-2005: Liabilities

5.9

3.8

2.1

6.2

6.4

10.3

3.9

Gohrband and Howell (forthcoming)4 Tables D, E

1990-2005:Difference

1.7

1.2

0.5

4.2

1.3

-1.9

0.4

1Returns in Forbes (2010) for components exclude holdings of
foreign official investors but these are included in total
returns.2Includes OC.3Excludes OC.4Gohrband and Howell (forthcoming) aggregate and FDI capital
gains include the value of capital gains that are included in
"other changes" for FDI, and calculate returns using the market
value of the FDI position.
.. not available

Table 4: Returns Differential Estimates, 1990-2011

Claims

Liabilities

Difference

of which: Return Effect

of which: Comp. Effect

Total: Total

7.0%

5.2%

1.9%

1.8%

0.1%

Total: Yield

5.4%

4.0%

1.5%

1.7%

-0.3%

Total: Capital Gains

1.6%

1.2%

0.4%

0.0%

0.4%

Total: Capital Gains of which: Price

1.5%

1.2%

0.3%

-0.1%

0.4%

Total: Capital Gains of which: FX

0.1%

0.0%

0.1%

0.1%

0.0%

FDI: Total

10.6%

4.7%

6.0%

FDI: Yield

10.2%

4.1%

6.1%

FDI: Capital Gains

0.4%

0.5%

-0.2%

FDI: Capital Gains of which: Price

0.4%

0.6%

-0.2%

FDI: Capital Gains of which: FX

0.0%

0.0%

0.0%

Debt: Total

7.4%

6.3%

1.1%

Debt: Yield

6.5%

5.9%

0.6%

Debt: Capital Gains

0.8%

0.4%

0.5%

Debt: Capital Gains of which: Price

0.8%

0.3%

0.6%

Debt: Capital Gains of which: FX

0.0%

0.1%

-0.1%

Equity: Total

7.5%

8.4%

-0.9%

Equity: Yield

2.6%

2.1%

0.5%

Equity: Capital Gains

4.9%

6.3%

-1.3%

Equity: Capital Gains of which: Price

4.5%

6.3%

-1.7%

Equity: Capital Gains of which: TX

0.4%

0.0%

0.4%

Other: Total

4.1%

3.2%

0.9%

Other: Yield

3.8%

3.3%

0.5%

Other: Capital Gains

0.3%

0.0%

0.4%

Other: Capital Gains of which: Price

0.2%

0.0%

0.2%

Other: Capital Gains of which: TX

0.1%

0.0%

0.1%

Notes: Return calculations through 2009 use the Gohrband and
Howell (forthcoming) Table 3 estimates of income and capital gains
for debt, equity, and other assets. For 2010 and 2011 we use the
IIP release for that year. For FDI we use the current-cost value of
the FDI position and infer capital gains on a current-cost basis on
FDI from BEA IIP Table 3, available online at
http://www.bea.gov/international/xls/intinv10_t3.xls.

Notes: Estimates are 1983-2010 averages from Curcuru and Thomas
(2012).

Table 6: Returns Differential Estimates for Two Sub-Periods

1990-2000:Claims

1990-2000: Liabilities

1990-2000: Difference

2001-2011: Claims

2001-2011: Liabilities

2001-2011: Difference

Total: Total

7.3%

6.4%

0.9%

6.7%

3.9%

2.8%

Total: Yield

6.0%

4.6%

1.4%

4.8%

3.3%

1.5%

Total: Capital Gains

1.3%

1.8%

-0.5%

1.9%

0.6%

1.2%

Total: Capital Gains of which: Price

2.0%

1.8%

0.1%

1.0%

0.5%

0.6%

Total: Capital Gains of which: FX

-0.6%

-0.1%

-0.6%

0.8%

0.2%

0.7%

FDI: Total

9.7%

3.6%

6.1%

11.5%

5.7%

5.8%

FDI: Yield

10.2%

3.2%

7.1%

10.3%

5.1%

5.2%

FDI: Capital Gains

-0.5%

0.4%

-0.9%

1.3%

0.7%

0.6%

FDI: Capital Gains of which: Price

0.1%

0.5%

-0.4%

0.6%

0.7%

0.0%

FDI: Capital Gains of which: FX

-0.6%

-0.1%

-0.5%

0.6%

0.0%

0.6%

Debt: Total

7.5%

6.9%

0.7%

7.2%

5.6%

1.5%

Debt: Yield

7.5%

7.2%

0.3%

5.6%

4.6%

0.9%

Debt: Capital Gains

0.1%

-0.3%

0.3%

1.6%

1.0%

0.6%

Debt: Capital Gains of which: Price

0.7%

-0.2%

0.9%

1.0%

0.7%

0.0%

Debt: Capital Gains of which: FX

-0.6%

-0.1%

-0.6%

0.6%

0.3%

0.6%

Equity: Total

8.7%

14.1%

-5.4%

6.3%

2.7%

3.6%

Equity: Yield

2.6%

2.4%

0.2%

2.6%

1.9%

0.7%

Equity: Capital Gains

6.1%

11.7%

-5.6%

3.7%

0.8%

2.9%

Equity: Capital Gains of which: Price

7.4%

11.7%

-4.3%

1.7%

0.8%

0.9%

Equity: Capital Gains of which: TX

-1.2%

0.0%

-1.2%

2.0%

0.0%

2.0%

Other: Total

4.7%

4.5%

0.2%

3.5%

2.0%

1.5%

Other: Yield

4.9%

4.6%

0.4%

2.6%

2.0%

0.6%

Other: Capital Gains

-0.2%

-0.1%

-0.1%

0.9%

0.0%

0.9%

Other: Capital Gains of which: Price

-0.2%

0.0%

-0.2%

0.7%

0.0%

0.7%

Other: Capital Gains of which: TX

0.0%

-0.1%

0.1%

0.3%

0.0%

0.2%

Notes: Valuation adjustments based on data (and, to update, the
recipe) from Table 3 of Gohrband and Howell (forthcoming). Returns
use the current-cost value of the FDI position.

Table 7: Returns Differential Estimates, 2012-2025

Claims

Liabilities

Difference

of which: Return Effect

of which: Comp. Effect

Total: Total

7.2%

5.3%

1.9%

1.6%

0.4%

Total: Yield

5.9%

4.6%

1.3%

1.6%

-0.3%

Total: Capital Gains

1.3%

0.7%

0.7%

0.0%

0.7%

Total: Capital Gains of which: Price

1.4%

0.7%

0.7%

0.0%

0.7%

Total: Capital Gains of which: FX

0.0%

0.0%

0.0%

0.0%

0.0%

FDI: Total

10.6%

6.2%

4.4%

FDI: Yield

10.6%

6.2%

4.5%

FDI: Capital Gains

0.0%

0.0%

0.0%

FDI: Capital Gains of which: Price

0.0%

0.0%

0.0%

FDI: Capital Gains of which: FX

0.0%

0.0%

0.0%

Debt: Total

6.8%

5.5%

1.4%

Debt: Yield

7.6%

6.3%

1.3%

Debt: Capital Gains

-0.8%

-0.8%

0.0%

Debt: Capital Gains of which: Price

-0.8%

-0.8%

0.0%

Debt: Capital Gains of which: FX

0.0%

0.0%

0.0%

Equity: Total

7.6%

7.1%

0.4%

Equity: Yield

2.6%

2.1%

0.5%

Equity: Capital Gains

5.0%

5.0%

0.0%

Equity: Capital Gains of which: Price

5.0%

5.0%

0.0%

Equity: Capital Gains of which: TX

0.0%

0.0%

0.0%

Other: Total

3.7%

3.3%

0.4%

Other: Yield

3.8%

3.3%

0.5%

Other: Capital Gains

0.0%

0.0%

0.0%

Other: Capital Gains of which: Price

0.0%

0.0%

0.0%

Other:Capital Gains of which: TX

0.0%

0.0%

0.0%

Assumptions: For DI income rates, the rate on liabilities
increases by 1.4 percentage points; the rate on claims remain at
long-term average. The income rate on debt claims and liabilities
increases by 4 percentage points by 2019 then remains constant,
with corresponding capital gains losses. Income rates on equity and
other assets remain at their long-term averages. Capital gains
return is 5 percent per year for equity claims and liabilities and
0 percent for all other asset types. The dollar value of the goods
and services deficit and net transfers deficit increase by 1
percent per year; capital flows increase to offset changes in the
current account (i.e., we assume zero statistical discrepancy).
U.S. nominal GDP follows the Blue Chip forecast (2.7 percent
average growth). The dollar is unchanged.

Figure 1: U.S. Net International Investment Position and
Cumulated Current Account

Source: BEA. The cumulated current series starts with the U.S.
net international investment position at the end of 1989 then
cumulates subsequent U.S. current account balances.

Dat for Figure 1

Net Investment Income

Net International Investment Position

Cumulated Current Account

1990

28.55

-230.375

-178.454

1991

24.13

-291.754

-175.556

1992

24.234

-411.021

-227.169

1993

25.316

-284.46

-311.975

1994

17.146

-298.458

-433.587

1995

20.891

-430.194

-547.154

1996

22.318

-463.338

-671.918

1997

12.609

-786.174

-812.644

1998

4.265

-858.363

-1027.71

1999

11.931

-731.068

-1329.36

2000

19.178

-1337.01

-1745.7

2001

29.728

-1875.03

-2142.3

2002

25.175

-2044.63

-2599.55

2003

43.691

-2093.79

-3118.64

2004

65.081

-2253.03

-3747.16

2005

68.591

-1932.15

-4492.93

2006

44.182

-2191.65

-5293.55

2007

101.485

-1796.01

-6003.86

2008

147.089

-3260.16

-6680.99

2009

119.717

-2321.77

-7062.89

2010

183.859

-2473.6

-7504.84

2011

227.007

-4030.25

-7970.77

Figure 2: Realized Returns on Cross-Border Claims and
Liabilities

Capital gains through 2009 implied from Tables D and E of
Gohrband and Howell (forthcoming); for 2010 from the IIP release.
Yields computed from BOP income and the 2010 IIP.

Data for Figure 2

top panel: Claims-Total

top panel: Liabilities-Total

mid panel: Claims-Yield

mid panel: Liabilities-Yield

bottom panel: Claims-Capital Gains

bottom panel: Liabilities-Capital Gains

1990

8%

5%

8%

6%

0%

-1%

1991

7%

8%

7%

5%

0%

3%

1992

3%

5%

6%

4%

-3%

1%

1993

10%

5%

5%

4%

5%

1%

1994

7%

3%

6%

5%

1%

-2%

1995

11%

11%

6%

5%

4%

6%

1996

8%

7%

6%

5%

2%

2%

1997

7%

9%

6%

5%

1%

4%

1998

9%

10%

5%

4%

4%

5%

1999

11%

6%

5%

4%

6%

2%

2000

1%

3%

6%

5%

-5%

-2%

2001

-2%

1%

5%

3%

-6%

-2%

2002

2%

0%

4%

3%

-2%

-3%

2003

15%

8%

4%

3%

11%

5%

2004

11%

5%

5%

3%

6%

2%

2005

10%

3%

5%

4%

4%

0%

2006

14%

7%

6%

4%

9%

3%

2007

13%

6%

6%

4%

7%

2%

2008

-14%

-4%

6%

4%

-19%

-8%

2009

15%

6%

4%

3%

10%

4%

2010

8%

6%

4%

3%

4%

3%

2011

1%

4%

4%

3%

-3%

1%

Figure 3: Income Earnings yields and Capital Gains on U.S.
Cross-Border Positions

Graphical depiction of the returns presented in the right side
of Table 4. Income is from the balance of payments reported by BEA.
Capital gains through 2009 are implied from Gohrband and Howell
(forthcoming); for 2010 from the IIP Direct investment valued at
current-cost. All values are 1990-2011 averages.

Data for Figure 3

Total: U.S. Claims

Total: U.S. Liabilities

Direct Investment: U.S. Claims

Direct Investment: U.S. Liabilities

Portfolio Equity: U.S. Claims

Portfolio Equity: U.S. Liabilities

Debt and Other Assets: U.S. Claims

Debt and Other Assets: U.S. Liabilities

Income

0.054235

0.039565

0.102375

0.041085

0.025771

0.021248

0.042999

0.044761

Capital Gains

0.016053

0.012167

0.003724

0.005456

0.049064

0.062522

0.004235

0.0022

Figure 4: U.S. Direct Investment Abroad (USDIA) and Foreign
Direct Investment in the United States (FDIUS) Earnings
yields

The USDIA series is the ratio of aggregate DI income receipts to
the USDIA position at current-cost reported by BEA. The FDIUS
series is the ratio of aggregate DI income payments to the FDIUS
position at current-cost reported by BEA.

The top line on the chart is the net income reported in the U.S.
BOP. Two alternative income estimates are shown. The dotted line
estimates income using the product of the net position and the
yield on aggregate liabilities; that is, it forces the yield on
assets to equal the yield on liabilities. The dashed line estimates
income by setting the USDIA income yield equal to that earned on
FDIUS.

GR1 and GR2 are total returns differentials from Gourinchas and
Rey (2007a) and Gourinchas and Rey (2007b), respectively; CTW is
from Curcuru, Thomas and Warnock (2009); and GH is from Gohrband
and Howell (forthcoming) through 2009, updated through 2011 using
2011 IIP data. For the relatively short time period (1990 - 2003)
for which all four estimates are available, average U.S.
differentials range from -1.5% per year (GR2) to +2.2% for GR1,
with CTW and GH at 1.0 and 1.2%, respectively.

Data for Figure 8

GR1

GR2

CTW

GH

1973

4%

3%

1974

4%

-2%

1975

5%

2%

1976

-2%

-6%

1977

14%

10%

1978

13%

9%

1979

18%

3%

1980

2%

0%

1981

-7%

-3%

1982

-2%

-9%

1983

6%

0%

1984

-3%

-4%

1985

6%

3%

1986

6%

3%

1987

5%

5%

1988

6%

0%

1989

1%

-3%

1990

2%

-2%

3%

3%

1991

0%

-4%

-1%

-1%

1992

-3%

-7%

-2%

-2%

1993

17%

6%

6%

6%

1994

5%

2%

4%

4%

1995

-2%

-7%

-1%

0%

1996

4%

0%

1%

2%

1997

-3%

-7%

-3%

-3%

1998

-3%

-6%

-1%

-1%

1999

8%

5%

5%

5%

2000

-2%

-4%

-2%

-2%

2001

-5%

-5%

-3%

-3%

2002

2%

1%

2%

2%

2003

12%

8%

7%

7%

2004

6%

6%

2005

7%

6%

2006

8%

7%

2007

6%

6%

2008

-9%

2009

8%

2010

3%

2011

-3%

Figure 9: Evolution of Net Income, the Net Position, and the
Current Account

Assumptions are as in Table 7. For DI income rates, the rate on
liabilities increases by 1.4 percentage points; the rate on claims
remain at long-term average. The income rate on debt claims and
liabilities increases by 4 percentage points by 2019 then remains
constant, with corresponding capital gains losses. Income rates on
equity and other assets remain at their long-term averages. Capital
gains return is 5 percent per year for equity claims and
liabilities and 0 percent for all other asset types. The dollar
value of the goods and services deficit and net transfers deficit
increase by 1 percent per year; capital flows increase to offset
changes in the current account (i.e., we assume zero statistical
discrepancy). U.S. nominal GDP follows the Blue Chip forecast (2.7
percent average growth). The dollar is unchanged.

Data for Figure 9

Net Investment Income

Net International Investment Position

Cumulated Current Account

2007

0.007919

-0.13312

-0.05063

2008

0.011044

-0.23929

-0.09708

2009

0.009112

-0.17247

-0.12662

2010

0.013176

-0.17822

-0.15251

2011

0.015589

-0.27571

-0.17758

2012

0.01316

-0.29834

-0.20558

2013

0.011616

-0.31676

-0.23326

2014

0.009008

-0.3324

-0.26091

2015

0.004866

-0.34672

-0.29077

2016

-0.00039

-0.36307

-0.32443

2017

-0.00368

-0.38835

-0.35994

2018

-0.00581

-0.4199

-0.3962

2019

-0.00797

-0.45431

-0.43376

2020

-0.00985

-0.49062

-0.47163

2021

-0.01189

-0.52761

-0.50996

2022

-0.01401

-0.56536

-0.54885

2023

-0.01621

-0.60395

-0.58836

2024

-0.0185

-0.64348

-0.62859

2025

-0.02088

-0.68404

-0.6696

Figure 10: Evolution of Net Income, the Net Position, and the
Current Account - Alternative Scenario

Assumptions are the same as for Figure 9, except for capital
gains rates which are 2 percentage points higher for claims in each
asset class.

Data for Figure 10

Net Investment Income

Net International Investment Position

Cumulated Current Account

Goods and services + transfers

2007

0.007919

-0.13312

-0.05063

-696.728

2008

0.011044

-0.23929

-0.09708

-698.338

2009

0.009112

-0.17247

-0.12662

-379.154

2010

0.013176

-0.17822

-0.15251

-494.737

2011

0.015589

-0.27571

-0.17758

-559.88

2012

0.01316

-0.27701

-0.20558

-559.88

2013

0.012772

-0.27456

-0.23211

-565.479

2014

0.01131

-0.26548

-0.25749

-571.134

2015

0.00856

-0.25344

-0.28376

-576.845

2016

0.004864

-0.24153

-0.31237

-582.613

2017

0.003246

-0.23631

-0.3413

-588.44

2018

0.002897

-0.2349

-0.36936

-594.324

2019

0.002677

-0.23356

-0.39695

-600.267

2020

0.002873

-0.23149

-0.42303

-606.27

2021

0.003055

-0.22737

-0.44766

-612.333

2022

0.003312

-0.22115

-0.4708

-618.456

2023

0.003648

-0.21278

-0.49244

-624.64

2024

0.004066

-0.20218

-0.51252

-630.887

2025

0.004572

-0.18928

-0.53102

-637.196

Footnotes

2.
A precise statement on the return effect is in Gourinchas (2006):
"The remaining two thirds (of the U.S. excess return) arise from
return differentials within asset classes. This reflects mostly the
ability of the US to borrow at very low interest rates, a fact
sometimes interpreted as evidence of the "exorbitant privilege"
that the US enjoys from its unique position in the international
monetary order, as the issuer of the world's reserve
currency." Return to text

3.
Factors more difficult to quantify, such as transfer pricing, might
also play a role in the DI yield differential. Return to text

4.
Our work also impacts another literature--comparisons of returns
differentials across countries--that we do not directly address in
this paper. As hinted at in the conclusion, however, we can show
that returns differentials are generally not comparable across
countries, a finding that would impact the Habib (2010) and Nguyen
(2011) papers. Return to text

5.
Along with balancing items to offset measurement errors, the OC
also picks up changes in valuation methodology and
reclassifications. An example of the latter is when a foreigner
becomes a U.S. resident. His prior claims on the US are no longer
U.S. liabilities to a foreigner and his prior claims on the rest of
the world become new U.S. claims on the rest of the world.
Return to text

6. Gian Maria Milesi-Ferretti points out
that for the US OC had been positive on net in 19 of 20 years prior
to 2012. Return to text

7. The returns differentials for GR2 can
be computed from
http://socrates.berkeley.edu/~pog/academic/IFA_data.xls, but are
not reported in that paper. We thank Alberto Fuertes for pointing
this out. Note that we show GR2 data from 1983 in Table 2, just so
it overlaps with the LMF2 sample. The GR2 aggregate returns
differential for 1973-2004:Q1 is -0.3%. See also Evans and Fuertes
(2011), in which an aggregate returns differential of 0.0% is
computed for 1973-2008. Return to
text

8. Including the yield differential of
about 1-1.5%, the overall returns differential was roughly
1-1.5%. Return to text

9. The volatility of international
returns, specifically capital gains returns, depicted in Figure 2
motivates the search for data sets that span longer time
periods--see, for example, the GR1 and GRG data that extend back to
the early 1950s. We fully agree that best for returns differentials
analysis would be the longest accurate time series
available. Return to text

11. "Other changes" for FDI does
include some capital gains and losses that should be included in
valuation adjustments, but these data are not available.
Return to text

12. We leave aside a third component, the
timing effect of Curcuru, Dvorak, and Warnock (2010). Return to text

13. We use current-cost rather than
market-value estimates of FDI positions for several reasons. One
reason is that it is highly doubtful that broad stock market
indexes can approximate the returns of privately held corporations.
Another problem is how to form an estimate of the return of USDIA
affiliates in tax havens, where much of USDIA is located; local
stock market returns, which are used in market-value measures,
clearly would not be appropriate. Parenthetically, we note that if
we did use market-value estimates for DI, the aggregate total
differential would narrow somewhat. Return to text

15. Other literature suggests that
foreign investments also include compensation for sunk costs
specific to investing in a foreign country. For example, in the
models of Helpman et al. (2004) and Fillat and Garretto (2010) FDI
investments are subject to sunk costs beyond those encountered
domestically. Fillat and Garetto (2010) estimate that compensation
for these sunk costs adds 25% to MNE yields relative to the yields
of domestic-only exporters. CT estimates that this accounts for
1.2-1.5 percentage points of the USDIA yield. For sunk costs to
impact the yield differential, however, they must be larger for
USDIA than for FDIUS. Return to
text

16. This estimate, based on Bernard et
al. (2006), is likely a lower bound, which would suggest the effect
of transfer pricing on the wedge between USDIA and FDIUS yields
might be greater than 80 basis points. Their sample and estimates
are for goods trade alone. Trademarks, patents, and other
intellectual property, where determining an "arms-length" price
is especially difficult, were not included in their
sample. Return to text

17. Investments in intangible capital are
generally excluded from the U.S. national accounts because of
difficulties in measuring its production and depreciation. BEA
plans to start including some intangible assets related to research
and development in the accounts in 2013. Return to text

18. In related work Hausmann and
Sturznegger (2006) infers from the large net income receipts that
USDIA intangible investment is much larger than FDIUS intangible
investment, although Buiter (2006) challenges their
methodology. Return to text

19. The dotted line in effect allocates
claims across instrument types with the same shares as liabilities
and sets the yields on each asset type to that on liabilities. The
dashed line computes the effect of the DI differential alone,
plotting what net payments would be with claims allocations and
yields set to their actual values except that the yield on DI
claims is set to the yield on DI liabilities. Return to text

20. More dramatically, as of 2010 the
cumulated dollar value of the gap between aggregate reported net
income and net income with equal DI yields was 90% of the total net
recorded liability position in that year. In 2011 capital gains
losses exceeded net income receipts by $530 billion. Return to text

21. This point also holds for capital
gains. Even if the average capital gains differential is small, it
can still produce large valuation adjustments in favor of the U.S.
because the differential was negative in the early part of the
sample when the gross positions were small, but positive later in
the sample after the gross positions had grown very
large. Return to text

22. To form this estimate, we start with
estimates of foreign taxes paid by country based on benchmark
survey data, then infer what additional U.S. taxes would be due on
the income receipts (assuming full credit for foreign taxes paid,
and including both repatriated and reinvested earnings). If instead
we limit the adjustment to only taxes paid on repatriated earnings,
aggregate net income would fall less, to $46 billion. Such
calculations are not yet possible for 2010, so our estimates for
this adjustment end in 2009. Return to
text

23. If the OC are not capital gains that
does not necessarily imply that they are missing flows. Some
reclassifications that should be captured in "other changes",
such as the immigration of wealthy individuals to the United
States, might be significant. Return to
text

24. The reader can enter her own
assumptions in NII_NIIP_workbook_Feb2013.xls. Note these are
assumptions to construct an illustrative projection and in no way
should be interpreted as a forecast endorsed by the authors or any
member of the staff of the Federal Reserve System. Return to text

25. Countries' income and holdings data
are not necessarily compiled using the same methods. One example:
Based on IMF BOP data, French FDI claims earned an average of 1.8%
per year from 2000-2009--this is the value that is likely included
in the Euro Area accounts, but a presentation on the Banque de
France website suggests that the return on French FDI equity
capital claims was about 5% for this period. We can identify a
likely reason for the discrepancy in this example--that French FDI
income excludes intercompany debt payments and earnings reinvested
in indirectly-owned affiliates--but other unidentified issues
undoubtedly lurk in the data. Return to
text

26. Excluding direct investment, U.S.
returns differentials are in line with the differentials for other
large developed economies including Australia, Canada, Japan, New
Zealand, as well as the Euro Area. Return to text